Startup Fundraising 101: When should you Raise Money from Venture Capital and Angel Investors

&nbspBy Martin Luenendonk|
2017-07-24T22:36:46+00:00 July 5th, 2017|

It almost always gets to a point where you, the founder, has to look for additional startup funding.

However, there are a certain factors you should consider before you begin raising money. One of the most important factors to consider is Timing.

It is commonly agreed that 90% of startups end up failing. According to a recent study of 200 failed startups, roughly, 12% of these fail due to bad timing in fundraising.

There are so many generic articles on the web that look at the tiny bits of when to raise money.

I take a different approach by looking at the major view points of entrepreneurs, venture capitalists, and researchers… and package everything into a easy to understand checklist.

This means, you simplly go through this guide and the more things you can check off for your startup, the better it is to raise money now.

Determining your Fundraising Readiness

Let’s find out when the best time to raise money for your startup is. But the best advice in a single statement is: ‘Don’t rush the process’.

Check #1 When you have an Effective Founding Team

You need to have an effective team before embarking on your fundraising journey.

There are a lot of great ideas out there. So investors aren’t necessarily looking for the next great idea, they are more interested in a team that can deliver; a team that can actually turn a vision into reality.

Remember it’s the millions of micro-decision that’ll make a business successful… also called execution. And it’s the team that performs those micro-decisions.

Only seek funding, when you have brought together an exceptionally effective team.

Venture Capitalists Tod Francis and Nikhil Basu Trivedi from Shasta Ventures published an analysis of the team compositions of 25 billion-dollar Unicorns and 7 soon-to-be Unicorns at the time of their Series A funding.

The goal was specifically to learn about their founding teams and what made these teams so strong and successful. What were the founders like?What were their backgrounds? What can you borrow from them?

These are the key findings. Startups founders can borrow from these in structuring their own teams:

Number of Founders

Most unicorns have 2 or 3 person founding teams.

This observation is supported by Thomas Koulopoulos, founder of the Delphi Group, a business consultancy company with over 25 years of experience. According to Koulopoulos, two-founder startups secure 30% more investments, grow their customer base three times faster, and are less likely to scale too fast.

Skills

The Shasta Ventures analysis also found that most unicorn teams primarily demonstrate skills in Product Management, User Experience, Strategic Partnerships, and E-commerce. The following chart demonstrates the skills possessed by founders of the Unicorns studied.

Educational Background

Most of these founders did not pursue advanced degrees. They appear to have opted for work experience.

Age and Experience

The analysis found that the average number of years of professional experience was 6 years while the average age of the founders at the time their companies were launched was 29 years. See graph below.

Note that there are two major clusters.

The first is the largest and consists of founders with minimal work experience, between 0 to 6 years.

The second cluster is significantly smaller and is comprised of founders with deep industry experience, between 12 to 17 years.

From my experience, successful B2B startups are more likely to be founded by entrepreneurs with deep industry expertise while successful B2C startups are dominated by younger startup founders.

Tip: This shows that industry experience alone can’t predict the effectiveness of a team. So, when choosing your team members it will be wise to look at the attributes of each person from a very individual standpoint. Ask yourself, ‘Despite their experience, will this person be a distinct asset to the team?’

Tip: Note that most of the analyzed Unicorns were software startups and the skill-set combination required for a founding team may be different from yours if you are in a different industry. The important thing is that you study successful companies in your industry and learn from the composition of their founding teams.

Ask: What skills did they possess? How many were they? What were their educational backgrounds? What can I borrow from them in putting together a team of my own?

Once you have a capable team in place, it is more likely that you’ll receive startup funding.

Check #2 When you have Some Traction

As we are all aware, there is a lot of talk in the world and very little delivery.

Remember, investors hear thousands of entrepreneurs talk about their ideas with very few ever yielding results. In fact, 9 out of 10 startups fail; that’s a 90 percent failure rate.

So if you want to stand out in the crowd you have to present clear-cut evidence showing that you are capable of turning your vision into a reality. What better way to provide this evidence than to have already made some progress with your idea?

‘There is a simple scorecard in business. Are you making money or not? Are you succeeding or not? So when you’re raising money, always, always catch yourself and eliminate the backstory.’

Every bit of traction is important for your future startup fundraising efforts.

You don’t have to make giant strides to gain traction, modest efforts like signing early clients, hiring key talent, or building your product/service by bootstrapping will all serve as positive signs to investors.

It will show investors that you’re passionate, resourceful, and that you’re driven enough to make it work even without sufficient capital.

By the time you approach investors you want to have them think,

‘If they can do this much with so little, imagine how much better they would be with our backing.’

Tim Ferriss, an angel investor, has also confessed,

“So, I look for consumer-facing products addressing a problem and that already have demonstrated traction of some type — like user adoption — that I can help dramatically.”

Check #3 When all the Business’s Books and Records are in Order

This supersedes merely seeking funds. This should be a full time commitment, fundraising or not. You should always have your business’s accounts and records in order.

There is no point in submitting a pristine pitch, one where there is undeniable merit to your product/service, business model… but with no accompanying records.

It’s actually quite disappointing to potential investors to later find out during the due diligence and then have to tell you ‘No, we won’t be investing in your startup’.

Before heading out to raise money it is important that you have the answers to these questions:

For your startup to be taken seriously and to avoid creating a negative first impression, all your records need to be in place, done correctly, and up to date.

So only venture out for startup fundraising when you have them all in order.

Check #4 When you have Validated Your Business Model

According to a 2016 Business Modeling Report by the Financial Reporting Council, it is unanimously agreed by investors that a business model is the foundation of their Analysis of a company, its Position, and itsProspects,

A working business model is the corner stone of any successful startup.

No matter how good your idea is, it is imperative to prove that it is viable enough to make money and sustain itself.

A good business model should generally address the following:

What is your unique value proposition?

What are the revenue streams?

What are the core activities of the business?

What is the cost structure?

Who are your key partners?

How do you plan to exit?

How will you build customer relationships?

What are your key capital requirements?

Having a business model prior to approaching venture capital and angel investors has its advantages:

Communicate what your business does: By developing a business model for your startup you present a clear and comprehensive definition of your business, it’s operations, how it generates revenue, and makes profit.

Internal Alignment: Developing and sharing your startup’s business model will help strengthen and align the understanding within your company.

Investor Trust: When you are able to demonstrate your team’s clear understanding of their business as well as its key drivers, you gain the confidence of investors and thereby have an easier time raising money.

Also important is the validation of your business model. It may just save countless hours and resources by revealing faults in your model, enabling you to change course early enough.

So, how can you validate your business model? There are three key steps:

Identify the problem and develop a solution.

Market validation. Does anyone want your solution?

Growth validation. How will you grow? Have you done anything to prove it?

The key word here is Market Research. Market research avails verifiable data that demonstrates the viability and sustainability of your idea. Without conducting market research and talking to real customers, your business’s idea is only sustainable in theory.

Comprehensive market research guarantees that you have an in-depth understanding of the problem you are solving, the effectiveness of your solution, and the need for that solution in the market.

This is important because by doing so you will avoid building something that nobody wants. In fact over 40% of startups fail because of coming up with a product with no market need.

Paul Judge, founder and CTO of Purewire says that he has had startups pitch him but when he asked about what their customers thought of their product/service they responded with a ‘We don’t know’.

It makes the investor wonder, ‘So why are you talking to me right now?’

Demonstrating a deep understanding of your market is extremely important to investors.

Dave McClure, 500 Startups founder says,

“Market size matters because most investors want to know that you’ve got a big business. Bigger is generally better.”

But according to a Startup Genome Report, startups that have never raised money tend to over-estimate their market size by 100 times and often misinterpret their market as new. So go out and do your research before you even think of fundraising.

Find out;

Is this a viable business that I am venturing into?

Do people actually want my product/solution?

Do I have a large enough market?

Will I be able to generate revenue with my current approaches?

Every business is a gamble, but it would be completely wasteful to spend time on and securing funding for a business that you are not sure has a chance of success.

Check #5 When you Figured Out Exactly How Much will be Enough to Drive your Current Initiatives

Before you knock on investors’ doors, you need to be clear on how much money you need as well as a justification for that amount.

There’s a big difference between ‘I need money to grow my startup’ and ‘I need $3,000 for an office, $5,000 for equipment, $5,000 for marketing, and $10,000 for the first product run.’

The latter indicates that you have a plan and it will also show potential investors exactly where their money is going.

Note also, it is not simply enough to have a number. It’s important to have a number that will enable you to accomplish something substantial; an amount that will see your business through to the next level.

So before you raise funding find out:

What major milestones do I currently have ahead of me?

How much time would it take to complete them?

How much would I need to successfully complete them?

Once you have figured this out, double the amount of time and money you estimated just to be sure. It’s much better to have a little bit more than to run out in the middle of operations. As a matter of fact, over 40% of funded startups fail because they run out of cash.

Meta Saas co-founder Arlo Gilbert who raised a $1.5 million seed round in May 2017 stated that it was important for him to decide on the amount he had to raise in the round in order for the company to achieve something meaningful.

He asserts that he did not want to raise just enough to keep the lights on for 6 months like most Austin startups do. Arlo says,

“I don’t understand how they get any work done or plan for the future with a rolling $25k at a time fund raise. I don’t think that is a good way to run your business. Raise enough to get you 12–18 months and hit growth to get you into the larger institutional investors (or profitability if that’s your goal).”

Check #6 When you know Exactly what Type of Investor is Right for your Startup

This may be surprising to many entrepreneurs, but it is extremely important to take due diligence serious and do your homework on potential investors.

What is their track record working with other startups?

What are their terms for funding?

How much control will they exercise?

Before you approach investors with a pitch, ensure that you have all the background information on all these potential partners.

Take your time speaking generally with them and asking questions. Be absolutely certain that whoever you eventually decide to pitch matches your needs, and vice versa.

It will save you a lot of headaches if you simply qualify and filter your list. Here are several criteria you can apply in eliminating investors from your list:

Reason to Eliminate

How to Determine

They have no funds

For VCs, you can find out from PEHub, Crunchbase, or general Google searches. For example, ‘Y Combinator raises funds’ to see when they last raised funds.

For Angels, look into their AngelList and LinkedIn profiles to see their recent activity.

They have invested in your competitor(s)

You can cross reference this on AngelList, Crunchbase, or on their website portfolio sections.

Wrong industry

For VCs, look into their individual websites, they are usually clear on which industries they primarily focus on.

For Angels, study their blogs and social media profiles to identify patterns. Every investor has some sort of inclination.

Bad reputation

This is a tricky one. Online sources may not give you accurate information on investor conduct. The best thing to do is ask around from people who have dealt with them, especially if you are in an accelerator group.

Wrong stage

This can also be tricky. When investors say they provide ‘growth capital’ it may actually mean they invest in later stages. So verify that whoever you are approaching actually invests in the earliest stages.

Wrong geo location

VCs and angel websites and profiles will often indicate their general areas of operation. If you do not fall within that region skip that investor.

Doing this will significantly enhance your hit rate once you start the investor outreach process.

Tip: Get Professional Advice. You can also approach capital business consultants who can help you discover the right investor. Professional help will also keep you aware of the sneaky terms investors slide in.

Check #7 When you’re clear on your Startup Valuation

The value of your Company is as much a matter of thought process as it is about spreadsheets. Therefore, if you don’t take the time to reflect and determine your valuation you will have wrong values on your spreadsheets.

Most investors will be experienced enough to see through inaccurate valuations. The Genome Report shows that founders often overestimate their value by over 200%.

Whether you have greatly over or underestimated your valuation, the image will be one of a Company that is not even aware of its own worth, which does not inspire confidence in potential investors.

So before heading out in search of funding have the answers to:

What is my pre-money valuation?

What is my anticipated post-money valuation?

How do I justify my valuation?

Tip: The more meaningful milestones your startup achieves before fundraising, the more likely you are to receive a desired valuation. The best performing VCs have a Milestone-based assessment when it comes to valuing a company. So find out what milestones you need to achieve in order to make your valuation seem more reasonable to investors when you pitch them.

Milestones could include;

Releasing your first viable prototype.

Signing your first hundred clients; proof that the market is big enough and that you have and audience.

Maintaining a cash-flow positive operation: proof that you have mastered the art of financial management.

Establishing an ongoing and stable relationship with industry strategic advisors and partners.

Check #8 When you have Some Reserves Set Aside

More often than not, the statup fundraising process is hectic and takes longer than anticipated.

So, before going down that road you need to plan accordingly and set money aside that carry your business through to the successful achievement of its current objectives.

Founder of the Delphi Group, Thomas Koulopoulos states that scaling too fast and too soon is the number one cause of company fails.

No founder has ever started their business thinking it will take them longer than anticipated, but it always does, because the vision and the actual market are two very different things.

For this reason, startups should plan accordingly and give themselves enough runway (have enough money) to successfully complete the objectives they have at hand and carry the business to its next level.

The most common reason why startups hit the end of their runway (when their money runs out) is poor cash-flow management.

Companies that make it out of the ‘valley of death’ (the space between launch and profitability) are able to do so because they keenly predict their financials, typically reserving twice as much as they need.

Nothing will make your fundraising journey more difficult than facing the prospect of running out of money before securing funding. It will lead you to desperation and desperation is not an attractive quality in a business any more than it is in people.

Most investors will run from you and those who do stay may end up proposing harsher terms than they would have had you allowed yourself a reasonable amount of time to save up before heading out to raise money.

Check #9 When there are No Other Viable Alternatives

Before you begin fundraising, be clear on the realities of getting funded. Don’t just raise funds because it is cool to do so. Ask:

Is my Company generating revenue as it is?

If so, can my Company grow healthily with the amount it’s currently making?

Can I afford to bootstrap and fund the Company myself?

Are there other options such government grants that I can exploit?

Tip: At the end of the day, running a business isn’t all about fundraising, so don’t get confused. It is much wiser to bootstrap for as long as you possibly can.

This way you maintain independence and control of your business as it’s growing while also allowing you to build something that is worth getting funded if it ever comes down to it.

Having an up and running product/service with some performance data to show investors will give you greater leverage if you decide to raise funds in the future.

So hold fast and only find investors when you are sure there are no better options out there that you have overlooked.

When to Raise Money from Venture Capital and Angel Investors in a Nutshell

As entrepreneurs, raising money is a great way to dodge the things we’re really afraid of.

The most obvious being the fear of failure. Raising money can enable us to delay that possibility for a certain period.

But if you’re raising money for the sole purpose of avoiding failure, isn’t that just delaying the inevitable?

I don’t know… that’s a debate for another day.

From personal experience, I have learnt that if you have to fail you’re better off failing fast. The sooner you realize that you’re up the wrong hill, the sooner you can get back down and find the right one.

If you find that your business is not quite ready to start raising funds, lay low and do not raise any.

You are better off spending that energy building your brand, building a customer base, putting together a stellar team, and achieving milestones. Focus on your Company and do not feel pressured to raise funds right away. Bootstrap!

Don’t embark on the fundraising journey until you are truly ready. It’s a waste of yours and the investors’ time and will in all likelihood create a negative first impression to potential investors who might have been interested in your startup had you been a little patient and really prepared yourself.

As you approach fundraising, it’s important to remember that fundraising itself isn’t the goal. It’s what the money enables you to do that will determine your future startup success.

So take the time to prepare your business using the checkpoints we have just discussed. And when you’re truly ready for it, the money you raise will be the fuel that skyrockets your business into success and beyond.